“Bitcoin — The Libertarian Introduction” — Erik Voorhees
What it is, how it’s used, and why you should care.
“When a state currency is challenged, the state itself is challenged, and market forces move swiftly around sickly, depreciating inhibitors.”
Introduction
There has been much talk about Bitcoin within libertarian and economic circles. It’s becoming a buzzword, but like all new systems that break onto the public stage quickly, Bitcoin brings with it excitement, speculation, rumor, and downright confusion. To be sure, Bitcoin is complicated. After all, it’s an entirely new global monetary system — both a currency and a payment network for that currency.
Like all powerful tools, it’s important for those interested in using Bitcoin to spend some time engaging in the due diligence of education. Similar to a bicycle, once you know how to use Bitcoin, it will feel very easy and comfortable. But also like a bicycle, one could spend years learning the physics that enable it to operate. Such deep knowledge is not necessary to the actual rider, and in the same way one can enjoy the world of Bitcoin with little more than a healthy curiosity and a bit of practice.
This article is a primer on Bitcoin: an overview of the fascinating new phenomenon from the perspective of a humble libertarian who cares more about the ramifications for human liberty than about the technical protocol and brilliant science underlying the network.
The basics of Bitcoin are all covered here, ranging from a light technical overview to due diligence to monetary economics and theory. You’ll also find an extensive list of resources to bring you up to speed on this most fascinating thing to happen in the realm of anarcho-capitalist technology since the internet itself.
What is Bitcoin?
Bitcoin is two things: it is a digital currency unit and it is the global payment network with which one sends and receives those currency units. Both the currency unit and the payment network share the same name: Bitcoin.
As a currency unit, consider Bitcoin like other currencies. The world has euros, dollars, yen, gold and silver ounces, and now it has Bitcoin as well. The properties of the Bitcoin currency unit are as follows:
· There will never be more than 21 million in existence, and they are released over time at a declining rate (at the time of writing, about 8.5 million Bitcoins exist).
· As new coins are released on the set schedule, they are given at random to those who contribute computing power to securing the network. This is called “Bitcoin Mining” but it should more accurately be called “Bitcoin Auditing.” Those who contribute more computing power to this work have better odds of receiving the new coins, but the rate of new coin creation never increases (in fact it diminishes over time until all 21 million coins exist). Inflation is thus pre-determined and ever-decreasing toward zero. The below graph shows the release schedule and inflation rate:
· Each Bitcoin is divisible by one hundred million. You can thus possess 0.00000001 Bitcoins.
· Bitcoins are perfectly fungible, they are divided and combined seamlessly in your account.
· It is theoretically impossible to make a fake Bitcoin (to fully understand why this is true, one needs to study cryptography and fairly advanced mathematics).
· As a currency existing in a perfectly free market, Bitcoins always have a market price. At the time of this writing, this price is about $4.80 each. Because Bitcoin is global, there are also market prices for Bitcoin in every major national currency from yen to Brazilian reals.
· Bitcoins are traded like other currencies on exchange websites, and this is how the market price is established. The most prominent exchange is MtGox.com
So those are the details of Bitcoin as a currency unit, but Bitcoin is also a payment network. As a payment network, Bitcoin replaces the function of banks (especially the Federal Reserve as money creation is not at the whim of any person nor group), inter-bank funding networks (like SWIFT and SEPA), payment processors (like PayPal) and remitters (such as Western Union). The entirety of these massive industries as they relate to the creation, storage, accounting, and transfer of money has been usurped by Bitcoin. If Bitcoin succeeds, it is likely that PayPal and Western Union would be removed from the marketplace. The Federal Reserve (and every central bank) would be made redundant. “Disruptive technology” is thus an understatement.
How does it work?
But how does Bitcoin work, you ask? How does it replace the functions for which we’ve so long relied on (and been beholden to) governments, banks, and payment companies?
To use Bitcoin, you traditionally download the software (though you can also use an “ewallet” system, discussed later). The software acts as your “bank account.” It stores a secret code on your computer, and this code enables funds to be spent from your bank account. In Bitcoin terminology, this bank account is called your “wallet.” So your wallet sits on your computer, and as soon as one has this wallet software one can receive and send Bitcoins to other wallet-holders anywhere in the world. It is as fast and easy as sending an email (easier because you don’t have to bother writing a message!).
You don’t need a name, an address, a Social Security/Slavery number, or any personal information of any kind. Nobody “approves” you for Bitcoin. It’s free and open-source software. You get it from Bitcoin.org.
Transactions are sent and accounts are secured using what’s known as “public key cryptography.” Every account has a public key and a private key — both of which are long strings of numbers and letters. Your wallet software knows your private key, and this allows it to send money. To send money to someone, you merely need to know their public key (basically their bank account number). If you have your private key plus their public key, a transaction can be created and the funds are deducted from your account and credited to the receiver’s account, without anyone else having a say in the matter.
As mentioned, your account is merely defined as a long string of numbers and letters:
bc1q5cevuvthfgm6kx97pg5srhkxmj4kzxxv3rww7j
Thus, your account has no personal information attached to it. You do not need to divulge any information whatsoever in order to obtain a Bitcoin account. This means you can receive, store, and spend Bitcoins with relative anonymity. The anonymity is relative because if you post your address anywhere that can be attributed to you (like on your Facebook page), then of course one can see that the account belongs to you, and money going to it would not be anonymous.
Bitcoin therefore works as a peer-to-peer network upon which account holders can transfer Bitcoin currency between accounts instantly and with relative anonymity. So long as an account holder protects her private key, her funds remain perfectly secure and only she can send them to someone else (and nobody can stop her).
Why is Bitcoin valuable?
This is perhaps the most important topic to address, as nothing else matters if Bitcoin has no value. What makes Bitcoin worth anything? Isn’t it just “fake”? Isn’t it just a made-up pretend virtual currency? Many say, “I can’t hold it, I can’t see it, and thus it’s artificial and not worth my time.” Let’s challenge this understandable initial reaction. Let’s demonstrate why Bitcoin is valuable, and very much worth one’s time.
Financial privacy has long been symbolized by the notorious “Swiss bank account.” Yet, anyone with a Swiss bank account has to trust that bank, and as we’ve seen in the last couple years, “bank privacy” even in Switzerland is a myth — banks there have been bending over for the US government and divulging customer information. So imagine having a private, numbered Swiss bank account, but without having to bother with the Swiss bank itself. That is Bitcoin. Instead of placing your trust in a regulated bank governed by fallible humans, Bitcoin enables you to place your trust in an unregulated cryptographic environment governed by infallible mathematics. 2+2 will always equal 4, no matter how many guns the government points at the equation.
Bitcoin is thus the only currency and money system in the world which has no counter-party risk to hold and to transfer. This is absolutely revolutionary and you should read the preceding sentence again. Gold advocates will point out that physical gold bullion has no counter-party risk, but that is only true for storage in your own home. Store it in a vault or bank and you have counter-party risk. And sending gold? You have to trust all sorts of people if you wish to transfer your gold somewhere else or spend it across distance.
Bitcoin means complete ownership of money both in storage and transfer. Nobody can prevent you from having it. Nobody can prevent you from spending it. Even if one’s home is broken into, or even if the government issues a “confiscation order” (as they did with gold in 1933), one’s Bitcoins are perfectly safe. Try fleeing a country with $1,000,000 in bullion without the government knowing about it. Easier said than done. With Bitcoin, it’s almost easier done than said — you could put $1,000,000 of Bitcoin on a USB drive, or even write the private key on a piece of paper, or just email the wallet file to yourself to be retrieved outside the country.
Starting to see the value? Never in the history of the world has an individual had this ability. It is unprecedented.
No really, WHY is Bitcoin valuable???
At this point, skeptics should say, “okay fine, you can store and spend Bitcoins without interference, but what gives them initial value? Why do they have a price?” It’s a very good question, and even expert economists have struggled with the answer.
But really, the answer is simple. Bitcoins have value because A) they are useful and B) they are scarce. Combine those two attributes in any asset and you will discover it has a price. The moment the first Bitcoin was traded to someone in exchange for something else, an exchange rate (market price) was established. Subsequent exchangers agreed or disagreed with that rate, and made further trades accordingly. Bitcoin thus spontaneously developed a price, as do all things in an open market if they are sufficiently useful and sufficiently scarce.
Let’s look at value a little further, because it’s a contentious issue with Bitcoin. There are many (including Paul Krugman) who believe Bitcoin isn’t worth anything and is no more than a speculative bubble fad.
I wouldn’t expect Krugman to “get it,” but wiser/real economists need only observe metals to start understanding why Bitcoins have value. After all, any strong advocate of gold or silver as money should hopefully understand why these metals should be money. The answer is that these metals tend to be chosen in an open marketplace as money, because their specific properties make them useful as a means of exchange. It is the properties of gold and silver — unique to these metals — which make them excellent money. They are scarce, fungible, uniform, transportable, have a high value-to-weight ratio, are easily identifiable, are highly durable, and their supplies are relatively steady and predictable. Contrast other goods like chickens, or seashells, or sand, and you discover that none of them are as good on the above attributes as precious metals. Chickens can’t well be cut in half or recombined, seashells are not uniform, and sand is too plentiful to be used as money. Why not other metals… why don’t we use iron as money? It’s not scarce enough — you’d need carts of it at the store to go shopping.
As any Austrian economist can tell you, money is merely that commodity in an open market which best satisfies the properties necessary for useful exchange. Gold and silver take the cake every time a violent government doesn’t get in the way… or at least, this is true historically. But, this doesn’t mean that gold and silver are “perfect, infallible money.” Indeed, there are practical problems. One can’t easily divide and combine silver coins to make change. One can’t easily send large values of gold across distance without hiring security and waiting for transport. One must pay storage fees, or risk theft at home. And, while difficult, it is possible to make fake gold and silver ingots and pass them off in trade as real.
So then it follows that if gold and silver are not perfect money (though admittedly the best we’ve had), perhaps mankind could discover or invent something that was even better. This is the Bitcoin experiment — the question of whether Bitcoin, with its specific attributes, is an even better form of money than what the marketplace currently enjoys (or in the case of state fiat, is forced to use). If the Austrians are right, and a marketplace tends to chose the medium of exchange which best works as money, and Bitcoin’s specific attributes make it excellent money, then perhaps the marketplace will, over time, increasingly use it for such.
The answer so far, is yes. Bitcoin is finding more and more niches for early adoption, which further supports its market price, providing confidence to holders that it will retain value, and this further lends Bitcoin to be used for still more purposes. It’s an organic and messy process, full of trial and error, potholes, brilliant innovations and terrible failures. But that’s what an open marketplace is, no? Every day a more resilient economy is being built, and not at the point of a gun, but voluntarily — not by decree of Bernanke, but by spontaneous, self-interested private order.
Many have made the argument that “nothing backs Bitcoin.” And this is true. Bitcoin cannot be redeemed for any fixed value, nor is it tied to any existing currency or commodity. But, neither is gold. Gold is not backed by anything — it is valuable because it’s useful and scarce. Cars are not backed by anything, they are merely useful as cars and thus have value. Food is not backed, nor are computers. All these goods have value in proportion to their usefulness and scarcity, and one merely needs to see the usefulness of Bitcoin to understand why, without backing from any government nor corporation, without being tied to any fiat currency or existing commodity, it commands a price on the market and rightly so.
How does one obtain it?
When one understands why Bitcoins are useful and therefore valuable, one might wish to obtain some. But how? Well, how does one obtain any currency? There are two basic ways, either by selling goods and services for it, or by buying it at an exchange.
We’ll examine buying at an exchange first. “Exchanges” are simply websites where buyers and sellers come together to trade one currency for another. If you have an account at an exchange, and fund the exchange with Bernanke Bucks, you can buy Bitcoins.
The practical steps for doing this are as follows:
Step 1) Create a free account at a trustworthy exchange like MtGox.com or (mainly for Europeans) BitStamp.net.
Step 2) Put money in the exchange by using an intermediary like Dwolla.com or (much faster with a small fee) BitInstant.com. Dwolla will link to your bank account and takes 3–5 days to move money from your bank to the exchange. BitInstant, comparatively, allows anonymous cash deposits up to $500 at a time and takes under an hour. These cash deposits are made by you at any major bank branch (you don’t even need a bank account). Within 30–60 minutes of your cash deposit, BitInstant will credit your exchange account with your USD. You can literally have your first Bitcoins 30 minutes after reading this article.
Step 3) Once your funds are at the exchange, you can buy Bitcoins at the current market price. The coins then stay at the exchange in your account until you send them somewhere else (to your personal wallet or someone you’d like to pay, etc). If you want to sell Bitcoins for dollars, you simply do the process in reverse — send the Bitcoins to an exchange, sell them at market price, and transfer the USD to your bank.
The Bitcoin market is fully-liquid and operates 24/7 with no holidays. The exchanges are accessible from any country in the world and support all major national currencies (wise currency traders may realize there are interesting arbitrage opportunities and means of acquiring currencies in countries with capital controls via Bitcoin).
The other way to get Bitcoins is to sell goods and services for them, just like you sell goods or your labor for dollars. Being able to receive Bitcoins is as simple as putting your Bitcoin address on your webpage, and you get this address automatically once you have a Bitcoin wallet. There is no “sign up” or “approval” to be able to accept Bitcoin. You can be any age, and in any country. Just get the wallet software (from bitcoin.org) or use an “ewallet” such as Paytunia.com, and paste your Bitcoin address for the world to see. Anyone who knows your Bitcoin address can send you Bitcoins instantly.
For small businesses who would like a more advanced way to accept and track Bitcoin payments for website orders, there are a few good merchant solutions. Paysius.com is the best — it will plug into your site (using common shopping cart plugins) and enable your customers to select “Bitcoin” as payment during checkout instead of credit card or PayPal, etc. (this doesn’t replace those methods, it merely gives your customers a new option). Further, because very few businesses can pay their salaries and suppliers in Bitcoin (yet), systems like Paysius give the business the ability to auto-convert incoming Bitcoins into normal USD and have that deposited in the company bank account. Fees are much lower than credit card processing, and Bitcoin payments have zero chargebacks or reversals (it’s impossible to reverse a Bitcoin payment) so merchants can securely accept payment from any country with no more risk of reversal, which should be a welcome relief to those who have been burned by PayPal or credit card fraud. Other than Paysius.com, Bit-pay.com is another good option for merchants to accept Bitcoin.
So that’s it — that’s how you get Bitcoins. Just buy them, or sell stuff in exchange.
Bitcoins are forgery-resistant because multiple computers, called nodes, on the network must confirm the validity of every transaction. It is so computationally intensive to create a bitcoin that it isn't financially worth it for counterfeiters to manipulate the system.